Iceland is being asked to repay a loan to the UK and the Netherlands.  This loan covers payments that those two large countries made to depositors in Icelandic banks that would otherwise not have got their money back – at least, in the short term.

First, the figures

Iceland has a labour force of 181,500, and a GDP of $12bn. So the debt of E3.9bn is about 50% of GDP.  Am I right?  So why does this article in the FT describe it as 250% of GDP? Also, as Paul Myners writes in today, ‘in the period up to 2016 a substantial proportion of the loan is expected to be recovered through the disposal of the assets of the failed bank Landsbanki’.  In which case, what is the estimated NET payment that Iceland is expected to bear?   Someone help me out.

Another issue: I understand that depositors were repaid IN FULL.  This is extraordinarily generous treatment given their foolishness.  How much would Iceland have been strictly liable for if it had only honoured commitments up to a limit?  Tim Worstall asks this question.  I am not sure what the actual answer is. But I do believe that larger depositors, getting years of generous interest rates, deserved some of the hit.

As do the UK and Dutch governments whose regulators bear some of the responsibility for allowing banks with liabilities of 11 times their country’s GDP to operate here. The terms on the loan seem relatively sensitive: repayments capped at 4% of GDP, and starting in 6 years’ time.  And the costs of not repaying ought to be fairly clear: becoming an international Pariah, as Lex argues.

Should simple fishermen, aluminium smelter workers and other Icelanders pay for this?  Well, for years they presumeably had the sort of high living standards that Daniel Hannan so embarrassingly extolled (well done LeftFootForward on this).  They may not have realised it, but some of their prosperity was based on the success of the banks.   But, yes, it is unfair to the individuals personally, and as the FT article above points out, repaying a foreign loan requires a steady export surplus, which is limited by the available haddock, in Iceland’s case.

The whole question of sovereign debt repayment throws up enough issues of democratic autonomy, justice, and coldblooded cost-benefit thinking that a simple answer is difficult to give.   Countries are not companies. They can’t go bust – but people can move (and many would happily take educated Icelanders).  Anyone who has read about the post WWI reparations fiasco (see Lords of Finance) understands the lunacy of demanding that a population pays what it can’t pay: hence the FT’s analogy with a debtor’s prison.

On the other hand, although ThoughCowardsFlinch seemed outraged that the cost of our future debt may determine the next election, but why should the rights of lenders count for nothing?

Robert Peston points out that most Icelanders were not consulted about the risks they were insuring. Advocacy international deplores what they see as big country bullying.

On the other side, with Paul Myners,  Jeremy Warner thinks a refusal would be disgraceful.

The comments under Martin Wolf’s provocative piece seem evenly split.  The first is excellent: the problem with being a pariah is sticking out.  Wait for Greece, Spain, Italy – then Iceland will look small beer.

So I have no verdict except: the debt is probably smaller than we think, and larger than it should be if more of the other foolish parties, in particular the savers getting great rates for years, took their just portion of the pain.

UPDATE: Scott Sumner has a good look at this here.  His summary of the cost-benefit side is quite pithy:

‘1.  Do countries have an ethical obligation to pay debts if doing so would hurt their citizens in utilitarian terms, even taking account of future punitive actions by others?’

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3 thoughts on “Icelandic dilemma

  1. Interesting to see you juggling the variables thus. Dave’s written on same at TCF, and I’ve commented as follows:

    ‘Giles at Free Thinking Economist is having similar thoughts. He will as likely as not take a different view based on assumptions about the value of liberal democracy/property rights than than what the likes of you conceive as democracy, and tie it to an understanding of morality that you don’t hold to. Nevertheless, it’s interesting to see an intelligent person writing from a liberal perspective juggling the same variables as you do here.

    I’ll simply copy this comment over to his post and see what turns up. If you win the debate, he will be required to change the name of his blog to Free-but-only-until-recently-within-a-liberal-paradigm-of-capital-dominance Thinking Economist. That’s only fair.’

  2. “But I do believe that larger depositors, getting years of generous interest rates, deserved some of the hit.”

    Certainly this would seem absolutely fair.

    But I think it’s abundantly clear that we’ve moved squarely into the realm of realpolitik. There’s significant domestic capital to be made by Labour and the Dutch Government playing hardball. (Though only up to a point; Brown already has a reputation as a bully – then again, it will be hard for Cameron to run the ‘let Iceland off and hurt UK taxpayers’ line).

    So I agree that, ethically, it’s very tricky to decide what is right and what is wrong. But I’m extremely sceptical that ethics will end up having anything to do with it, in practical terms, whatsoever.

    “A prince never lacks legitimate reasons to break his promise.”

    – Nicolo Machiavelli

  3. Good old Nico. I listened to the Prince while delivering leaflets in Richmond, and ended up thinking: ‘The libdems would be so much more effective if only they had a crew of determined people, with halberds’

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